A manufacturing company incurs both manufacturing costs (also called, product costs) and nonmanufacturing costs or expenses (also called, selling and administrative expenses). In the illustration below you can see the difference between manufacturing and nonmanufacturing costs and their classification.

Illustration 1: Manufacturing vs. nonmanufacturing costs

Let us review these types of manufacturing and nonmanufacturing costs in more detail.

Manufacturing costs are the costs that a company incurs in producing a product.

From the managerial accounting standpoint, there are three types of manufacturing costs:

1. Direct materials
2. Direct labor
3. Factory (or manufacturing) overhead

Direct materials are raw materials that become an integral part of the finished goods.

Direct materials should be distinguished from indirect materials (part of overhead costs), about which we will talk later.

Direct materials always have a variable nature.  Recall from other lectures that variable costs change in proportion to production.  For instance, in our example of Friends Corporation, the company purchases metal parts (raw material) to produce valves.  The more valves are produced, the more parts Friends Corporation has to acquire.  Therefore, parts have a variable nature; the amount of raw materials bought and used changes in direct proportion to amount of valves created.  For Friends Corporation, other direct materials would include, for example, plastic parts and paint.

Different manufacturing companies will have different direct material costs depending on the types of finished goods they produce. The table below provides a few examples.

Illustration 2: Examples of direct material costs

From the table you can see that direct materials are the integral part and a significant portion of finished goods.